OSC clarifies definition of index fund

The Ontario Securities Commission (OSC) is taking steps to clarify the definition of index funds. Investment funds whose sponsors want to call them index funds must meet two conditions, the OSC says: an absence of discretion; and transparency of the index.

These conditions are contained in an OSC staff notice published on Thursday in response to an increase in prospectus filings by investment funds that purport to be index-tracking funds.

“Where these conditions are not satisfied, in the course of our prospectus reviews, we will ask that references to the purported index in the fund’s investment objectives and name be removed,” the notice says.

“In order to be an index tracking fund, the methodology governing the index whose performance is being replicated should generally not allow for the application of material discretion on the part of the index provider or any other party involved in the administration of the index,” the notice says. “This means that the index should use objective and verifiable data as inputs, and the methodology should specify the rules by which the material aspects of the index, such as index value, weighting and constituents, are determined given such inputs.”

If the methodology does rely on significant discretion, the OSC indicates, it will generally view that methodology as more akin to an active investment strategy.

“We think that it is misleading to investors to refer to such a strategy as an ‘index’ in the fund’s name and investment objectives, or to market the fund in a way that suggests that it is an index tracking fund,” the notice says.

In addition, OSC staff expect the index to be transparent by making the methodology, or the constituents of the index, available to the public and by updating the list of constituents as the index is rebalanced. The fund’s prospectus should adequately describe the index, its methodology and components, along with the fund’s tracking method, the notice says.

“Transparency of the index assists investors in understanding the index to assess whether the index tracking fund is an appropriate investment,” the notice says. “Generally, staff will expect the methodology to include sufficient detail to assist in making such a judgment.”

While funds can track indices without disclosing the methodology, or the constituents of the index, OSC staff will generally take the view that it is inappropriate for the fund to market itself as an index tracking fund in these cases, the notice concludes.